PowerPoint Slides to accompany

Auditing and Assurance Services in Australia 4th ed.

By

Grant Gay & Roger Simnett

Slides prepared by Roger Simnett

Copyright © 2010 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger SimnettSlides prepared by Roger Simnett

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Part One

The Auditing and Assurance Services

Profession

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Chapter 1

Assurance and auditing: an overview

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Learning objective 1: The framework for assurance

engagements• Many parties provide reports to users as

an aid to making decisions.

• Reports are potentially biased due to the vested interests of the report providers.

• Users may demand that the credibility of the report be enhanced by having an independent expert examine it.

• Financial statements are just one type — the most common — of report that can be assured.

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Definition of assurance engagement

• Assurance engagement:

‘an engagement in which an assurance practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria’.

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Diagram of assurance engagement

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Five elements of assurance engagement

1. Three-party relationships:– Practitioner (auditor)– Responsible party (preparer)– Intended user

2. Subject matter

3. Suitable criteria

4. Sufficient appropriate evidence

5. Written assurance report

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Why is there value in the assurance service?

• Independence: – Users derive value from the knowledge that the

assurance provider has no interest in the information other than for its usefulness.

• Expertise: – Assurers must have the competence

to obtain sufficient relevant information to provide a reasonable basis for their conclusions.

– Requires professional judgement and professional scepticism.

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Professional judgement and professional scepticism

• Professional judgement: – Users derive value from the knowledge that the

assurance provider has no interest in the information other than for its usefulness.

• Professional scepticism: – An attitude that includes a questioning mind, being alert

to conditions indicating possible misstatement and critically assessing audit evidence.

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Learning objective 2:Structure of assurance standards and pronouncements

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Levels of assurance

• For any subject matter, two levels of assurance can be provided:1. Reasonable assurance2. Limited assurance.

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Reasonable assurance (Figure 1.3)

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(cont.)

Copyright © 2010 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger SimnettSlides prepared by Roger Simnett

Limited assurance (Figure 1.3 cont.)

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Level of assurance on financial statements

• Reasonable assurance engagements are commonly called 'audit engagements'.

• Reasonable assurance = positive expression of opinion.

• Limited assurance engagements are commonly called 'review engagements'.

• Limited assurance = negative expression of opinion.• There are also engagements that provide

no assurance: – Agreed-upon procedures engagements and reports of

factual findings.

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Attest v direct reporting

• Audit and review engagements can involve either an attest or a direct reporting engagement.

• Attest reporting engagement: – The auditor issues an opinion on written assertions made by

the party responsible for the subject matter.

• Direct reporting assurance engagement: – The auditor issues an opinion directly on the subject

matter (no written assertion is made by the party responsible for the subject matter).

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Learning objective 3:Auditing defined

• A Statement of Basic Auditing Concepts (ASOBAC — the American Accounting Association) defines auditing as:

‘A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria, and communicating the results to interested users.’

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Auditing defined (cont.)

• The important parts of this definition: – Systematic process — audits are structured activities– Objectivity — freedom from bias– Obtaining and evaluating evidence — allows the auditor

to determine the support for assertions or representations– Assertions about economic actions and events

— describes the subject matter of an audit– Degree of correspondence … established criteria

— the purpose of the audit is to determine conformity with some specified criteria

– Communicating results — the results must be communicated to interested parties

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Learning objective 4: Fundamental principles underlying

an audit• The International and Australian Auditing Standards

Boards released a draft paper in which they outlined possible fundamental principles underlying an audit. These principles should:

– Underpin the objective(s) of an audit, and help drive the conduct of the auditor in using professional judgment to meet the professional requirements of the auditing standards

– Be easily understood, both by auditors and other readers of auditing standards

– Be universally applicable to all audits– Entrench the expectations that auditors are

expected to accept and abide by.

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Ethical principles• Contained in national and international codes of

ethics: – Integrity

– Objectivity

– Professional competence and due care

– Confidentiality

– Professional behaviour

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Fundamental auditing principles

• Knowledge• Responsibility• Quality control• Rigour and scepticism• Professional judgement• Evidence• Documentation• Communication• Association• Reporting

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Learning objective 5:Attributes of accounting information• From AASB/IASB framework, the following four

attributes of accounting information provide the basis for the audit function:

– Relevance

– Reliability

– Comparability

– True and fair presentation

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Learning objective 6:Demand for assurance

• Demand arises because users are not in a position to establish the credibility of the information they are presented with. This may be due to:– Conflict of interest — managers may present biased

information, as they are also evaluated on the information.– Consequence — information provided forms the basis

of many users’ decisions.– Complexity — many users do not have the expertise

required to determine the quality of information presented.– Remoteness — the separation of owners from management

prevents users from assessing information quality.

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Hypotheses explaining demand for assurance

1. Agency theory (stewardship hypothesis)

2. Information hypothesis

3. Insurance hypothesis

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Agency theory

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Learning objective 7:Other benefits of assurance

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• An assurance service may also result in one or both of the following:

• Recommendations by the assurance provider to improve the efficiency and effectiveness of operations; and/or

• A positive influence on the behaviour of people whose activities are being assured.

Copyright © 2010 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger SimnettSlides prepared by Roger Simnett

Learning objective 8:The evolution of the audit function

• Audits have been performed since at least the thirteenth century.

• Until the early 1900s, audits focused on a company’s solvency and the detection of fraud and error.

• Audits from early 1900s to 1940s – added objectives of verification of financial report accuracy and attestation to financial report credibility.

• Since the 1940s, the overall objective of auditing has been the expression of an opinion as to whether the financial report is materially misstated.

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Approaches to Auditing

These have evolved over time:• Statement of financial position approach — this involved

the auditor auditing the assets and liabilities with little emphasis on profit and loss account items.

• Transactions-cycle approach — this emphasised the review of controls that operated within each transaction cycle and provided for limited testing of balance sheet items.

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More recent audit approaches

• Financial risk approach– The auditor considers relative financial risk and materiality

in planning the audit, such that audit work is concentrated in areas where there is a higher risk of misstatement.

• Business risk approach (audit risk approach)– As well as financial risk, the auditor considers business

strategy, associated business risks, and management’s plans to respond to changes in the business environment.

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Example of business risk approach• Refer Example 1.1 on page 13 of textbook.• The auditor uses a risk-based assertion-based methodology

in undertaking the audit. For example, the assertions that management are implicitly making by recording an inventory balance of $1 million in the statement of financial position are:• Inventory of $1 million exists (existence);• The entity has the rights of ownership of this inventory

(rights and obligations);• All inventory that should have been recorded has been

recorded (completeness); and• Inventory has been recorded in the financial report at the

appropriate value, and any resulting valuation adjustment (such as obsolescence) has been correctly recorded (valuation and allocation).

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Example of business risk approach (cont.)• The auditor uses a risk-based methodology to identify risks of

misstatement and relates these through to assertions (Chapters 6–8). For example, consider that the auditor identifies major risk as entity wishing to overstate profit. They can achieve this by overstating inventory, which understates cost of goods sold (if goods are in inventory, they are not sold). The auditor assesses how entity is likely to achieve this overstatement, and concentrates their audit attention on the related assertions.

• In this example, two ways of achieving overstatement of inventory are to include inventory that does not exist (for example, goods that have been sold) or overstate valuation of the inventory items included in the statement of financial position (valuation and allocation). The auditor then uses specific procedures to test assertions at risk (Chapters 9-11).

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Learning objective 9:The auditor–client–public relationship• The auditor’s primary reporting responsibility

is to resource providers of the client entity; however, the client entity usually engages the auditor and pays the auditor’s fees.

• The auditor also discusses the audit findings with management prior to releasing information to the resource providers.

• In order to combat pressures on independence and objectivity, the auditing profession has issued a series of ethical rulings and professional standards to guide the auditor in the conduct of his or her duties.

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Learning objective 10:Expectation gap

• Defined as: ‘the gap between society’s expectations of auditors and auditors’ performance as perceived by society’.

• There are 3 components of the expectation gap:1. The reasonableness gap between what society

expects auditors to achieve and what they can reasonably be expected to accomplish.

2. The performance gap arising from deficient standards.

3. The performance gap arising from deficient performance by auditors.

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The gap between audit expectation and audit performance

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Four major issues in the expectation gap

1. The nature and meaning of audit report messages

2. Early warning by auditors of corporate failure

3. Auditor’s responsibility for the detection and reporting of earnings management and fraud

4. The auditor’s ability to communicate different levels of assurance

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Learning objective 11:The role of auditing standards

• Auditing standards in Australia are developed by the Auditing and Assurance Standards Board (AUASB).

• The standards prescribe the basic principles and essential procedures governing the conduct of an auditor.

• For audits conducted under the Corporations Act 2001, the auditing standards (ASAs) must be applied, thus giving them legal authority.

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The role of auditing standards (cont.)• Guidance Statements (GSs) or Auditing Guidance

Statements (AGSs): provide guidance on procedural matters or industry-specific issues, but do not establish new principles or amend existing standards.

• Professional obligations extend application of standards to all other audit and assurance engagements by members of professional bodies.

• Failure to observe these standards may expose a member to investigation and disciplinary action from the Australian Securities and Investments Commission (ASIC).

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Authority of auditing standards

• Auditing standards applying to audits and reviews of financial reports prepared in accordance with the Corporations Act 2001 :– Australian auditing standards relating to these

audits are now designated as ASAs, and have the same numbering as the equivalent ISAs.

– Note: there are still a number of standards designated as AUSs, which relate to frameworks or assurance engagements on other than financial reports prepared in accordance with the Corporations Act 2001.

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Learning objective 12:Audits under Corporations Act 2001

• Management is responsible for the preparation and presentation of appropriate accounts. Accounts are to be accompanied by a report of an independent auditor appointed by the shareholders.

• The Corporations Act 2001 (ss 292–306) indicates that directors must prepare a financial report (income statement, balance sheet, statement of changes in equity cash flow statement, directors’ declaration and other related notes and reports), together with any other information or explanation necessary to give a true and fair view.

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Auditors’ responsibilities under the Corporations Act 2001

• Auditors are responsible for reporting to company members on the directors’ financial report presented at the AGM.

• They say whether the financial report:

– Is in accordance with the law, including compliance with accounting standards (s 296)

– Provides a true and fair view (s 297).

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Learning objective 13:Other applications of the assurance

function

• Evidence-gathering methods of auditing are also employable in the audit of activities other than financial reports.

• Compliance audit: – Examination for the purpose of reporting on legality and

control of operations.

• Performance audit: – Analyses organisation structure, internal systems,

workflow and managerial performance — efficiency, effectiveness and economy of these items.

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Other applications of the assurance function (cont.)

• Comprehensive audit: – Usually includes components of compliance,

performance and financial report audits.

• Internal audit: – Audits performed by employees of the entity as a part of

the entity’s risk management process.

• Forensic audit: – Associated many times with fraud detection.

• Assurance on subject matter other than historical financial information: – Including prospective financial information, internal

controls and sustainability and carbon emissions reports.

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